Iberia gets down to business

01 April, 1999

SOURCE: Flight Airline Business

With the BA equity deal all but sealed, membership of oneworld under its belt and full privatisation slated by year end, Iberia has much to be cheerful about. But while the Spanish flag carrier reinvents itself as a serious international business airline, it will need to keep a close eye on the faltering South American market.

"This is just the beginning of the transformation of Iberia," promises president and chief executive Xabier de Irala. The Iberia chief is not lacking in ambition - and this year he will need plenty of it, as well as more of the management skills that have already turned a basket case into an airline that commands growing respect.

Most observers, including Bob Ayling, chief executive of Iberia's new shareholder British Airways, believe Irala is the man to take the carrier forward into the new millennium as a privatised company locked into one of the industry's leading global alliances.

There is no doubt that Iberia has made a major recovery since Irala took the helm in 1996. If the carrier's predictions are correct, it will record its third consecutive year of profit growth for 1999 with another steady rise in margins. Less than five years ago, Iberia had a reputation as a typical state company riddled with losses, but expects to have emerged from 1998 showing the highest profit margin of any state-owned European airline. For this year, Iberia projects a return on equity of over 20%.

In guiding Iberia on its path back to health, Irala has extricated the carrier from disastrous Latin American investments, selling Chilean carrier Ladeco, closing down Venezuelan flag carrier Viasa, and restructuring and reducing its stake in Aerolineas Argentinas to 10%. In this way, Irala ended an episode that cost the Spanish flag carrier $1 billion between 1991 and 1995, accounting for 50% of the group's losses.

Debt falling

Irala has also overseen a reduction in Iberia's debt by almost $900 million since 1994, helped by Spanish state aid. And this is set to fall further, according to sources close to the company.

By pursuing an aggressive pricing and marketing strategy, Irala has helped Iberia win back domestic market share, which now stands at 76%. The carrier is also beginning to tackle its major headache - low yields. Iberia's premium cabin contributes just 40% of revenue - some 10 percentage points behind BA. "Yield will be much better targeted in 1999," says Irala. This will be achieved through a yield management system introduced last year and a renewed focus on premium traffic, he says.

In February, Irala unveiled the first phase of a $50 million programme to upgrade its first and business class products - the launch of its intercontinental business class. It plans to add 50% capacity to this crucial profit-generating market segment over the next three years.

In a bid to boost efficiency, Iberia is investing $4.1 billion in a new Airbus fleet. The 76 short- and medium-range aircraft will gradually replace its McDonnell DouglasDC-9s, Boeing 727s and Airbus A300s, leaving the airline's operations in this segment with just two fleet types - the A320 family and MD-80s - by 2004. As for long haul, Iberia already has eight Airbus A340s in service and 11 more on order, but has yet to decide on replacing its 747 fleet. It is considering Boeing 777s, 747-400s or Airbus A340-600s.

The airline has made further savings by buying the remaining 67% stake it did not own in its 25-aircraft subsidiary Aviaco from domestic Spanish state holding company SEPI, and integrating the planning of Aviaco's operations into the Iberia mainline network, raising the subsidiary's productivity by 25%.

Irala says Iberia is ahead of the target set in the company's Director Plan to reduce costs by 15% over the three years to 2000. This has been achieved partly by spinning off the group's cargo, maintenance, ground handling, catering and information technology activities into separate profit centres. Irala, who says all these subsidiaries are now achieving positive results, wants to push the process forward by turning them into legally separate companies by the end of the year. Some of the subsidiaries evidently have the potential to become stand-alone operations - Iberia's ground handling unit, with a $620 million operating income in 1997, is Europe's largest, claims Irala.

But he says there is still plenty to do. "We have the lowest aircraft utilisation in Europe," he says. And despite a 25% cut in the payroll since 1992, an 8.3% average pay cut since 1995, and rising ground and flight staff productivity, Iberia's workforce is still relatively unproductive in European terms. Irala's solution is to focus on removing any activities that are not "adding value for the customer" and linking wages more closely to productivity.

Privatisation

As well as getting the company's operations in order, much of Irala's time in the coming months will be spent on completing the privatisation process and building on the airline's recently sealed alliances with BA, American and oneworld.

The sell-off of Iberia by state holding company SEPI is a relatively ambitious exercise. A headline figure of Ptas580 billion ($3.8 billion) has already been set for the 9% stake that BA, and the 1% stake that American agreed to buy in February. But the final price and ownership terms are due to be finalised at the same time as Spanish institutional investors come in with a 30% stake by June. Among the details to be worked out are the valuation of Iberia's 29% stake in the Amadeus computer reservation system. Iberia hopes the remaining 54% stake (employees already own 6%) will be listed on the Madrid stock exchange at the end of July, but observers believe it may be later in the year.

Once Iberia is publicly owned, its management may finally be able to assert its right to manage. Even some union representatives would agree that political interference has prevented the company from achieving its full potential. Irala, who was hired to take the carrier into the public sector, says he took on the job only after making it clear to the government that it would take just "one phone call" from on high to provoke his resignation. But despite the chief executive's claim that the government has honoured its part of the deal, senior sources at the airline say it continues to suffer pressure from local and regional governments to maintain unprofitable routes. Iberia recently boosted capacity to the Canary Islands by 40% but has seen only a 25% increase in revenue.

Ground staff unions suggest that problems of management control could persist after privatisation. One of the favourites to bid for a tranche of the 30% stake allotted to Spanish institutional investors is conglomerate El Corte Ingles, which has extensive tourism interests. Unions say this may lead to boardroom clashes with BA.

This possibility obviously did not escape BA, American or the Spanish government. According to informed sources close to the company, the government has structured the privatisation deal in such a way that on the future 12-seat management board, BA and American's two seats will effectively become five. This is because if the Spanish institutional investors, with three seats, consistently vote against BA/AA, the latter have the right to buy them out.

In terms of the core business of flying, the alliance with British Airways will focus on codeshares in Europe and between Europe and Latin America. The first wave of codesharing will begin in June and the rest in November, says Iberia's head of alliances, Guillermo Serrano. Initially, the carrier will place its code on connections to UK provincial cities out of London as well as on European routes that it does not serve at present, such as Oslo. BA will add its code on Iberia's flights out of Madrid to Spanish regional destinations. In Latin America, Havana is on the codeshare list, and Singapore, Bangkok and Nairobi are other new codeshare destinations.

As for cooperation on the main trunk routes, such as London-Madrid and Barcelona-London, Serrano knows this will raise more than an eyebrow in Brussels, and will have to wait for anti-trust immunity. But, he adds, with the high level of frequencies served by both carriers on this route, "it is not a necessity to codeshare".

Analysts says BA's buy into Iberia gives it a unique opportunity to offload its loss-making short-haul network to Iberia. The Spanish airline claims to be profitable in Europe and, unlike BA, does not have the same capacity problems at its hub.

"Conceptually," says Irala, "there is no question that if Heathrow is saturated, we can-help BA grow. We can help BA consolidate its position in Europe. We can bring our Latin American network. We also can contribute to BA's Asian network where we are not present." Irala also says BA will benefit from its strength in Spain, and Iberia's "leadership position in Latin America".

Iberia is also keen to stress the advantages of its Madrid base. "Barajas has as large a potential as any European hub, bar Charles de Gaulle, and its available air platform is even larger."

Although Madrid/Barajas is saturated now, he says, a third runway will be completed this year, boosting aircraft movements from 50 to 75 an hour. Also, there are no planning obstacles for fourth and fifth runways. A new cargo terminal is also set for commissioning in mid-1999, and Iberia will have a dedicated terminal at the airport within three years which, adds Serrano, it intends to share with its BA, American and oneworld partners.

Iberia is also planning to develop Barcelona as a northern Spanish hub, able to draw in traffic from the south of France, Italy and elsewhere, and will launch a direct Barcelona-New York service later this year.

Seeking synergies

BA's buy into Iberia was tied to "a broad co-operation agreement" which promises to net annual savings of Ptas18 billion for the two companies through lower costs and revenue increases within three years, says Serrano. The two companies aim to maximise synergies across all their passenger, freight and ground services, he adds, and Iberia will "eventually simplify headcounts" - although he is keen to stress that expansion in other areas will create jobs. Serrano also points out the advantages of greater market presence in certain fields. "BA's cargo operations, unlike those of Lufthansa and Air France, do not have a particularly high profile, but BA and Iberia together have a substantial capacity."

In contrast to the virtual merger with BA, Iberia's alliance with American Airlines, cemented by joint ownership of Aerolineas Argentinas and American's 1% stake in Iberia, is set to remain within "the framework of oneworld", says Serrano, and will therefore be a looser agreement to start with. The marketing deal signed by the two carriers in May 1998 involves codesharing between Spain and 22 destinations in the USA, linked frequent flyer programmes and cooperation in cargo. The deal has already boosted revenues by 30% on the jointly operated routes, says Serrano.

In February, having concluded the 18-month negotiations with the Spanish government over the equity stake in Iberia, BA and American opened the door to their global alliance, oneworld. Irala and Serrano are now gearing the airline up for full membership of the five-carrier tie-up, which Iberia will join in September along with Finnair. Serrano says preparations primarily involve making staff aware of oneworld and linking Iberia's frequent flier programme with other oneworld members. Iberia also aims to "explore opportunities" with Qantas, Canadian, Finnair and Cathay Pacific, such as adding Sydney, Melbourne and Vancouver to its network.

So is it all blue skies ahead? Not quite. Iberia's bid to build on its position in Latin America involves raising transatlantic capacity - boosting non-stop connections, mostly to Latin America - by one-third this year. This comes at a time when carriers are cutting back on growth on the Atlantic and Latin America is in economic difficulties. However, Iberia is confident that it has the flexibility to slow capacity growth and will do it in time. Martin Borghetto, an analyst at Morgan Stanley in London, says that with Latin America, Iberia is in a similar position to airlines exposed to Asia: "There are short-term problems, but in the longer term, it is a growth area."

Iberia has other hurdles to clear, such as perception of quality. Serrano says that admission to oneworld is evidence that it has made the grade. Borghetto points to the fact that "...from a carrier with low yields, low profile and no pride, Iberia is now linked to an airline at the forefront". However, the investments in the premium cabin suggest that it has not yet hit the mark.

So can Iberia keep up the momentum? By his record so far, Irala seems to offer the promise that it will. n

Iberia is investing heavily in upgrading its intercontinental business class product, which includes a limousine service and a 132cm seat pitch.

"If Heathrow is saturated, we can help BA grow, to consolidate its position in Europe" Xabier de Irala

Low-cost challenger

Spain has not been saved from the incursions of foriegn majors or UK-based low-cost carriers such as Debonair and easyJet. It also has to contend with more aggressive competition from the likes of Portugalia out of Lisbon, and a growing challenge to it preeminence in the Spanish islands. But Iberia may be better placed to defend its territory than most incumbents.

Iberia claims that years of exposure to cut-throat competition from charter carriers have left it well prepared. According to chief executive Xabier de Irala, the average ticket price per kilometre in Spain is "at least 20% lower than any other European country, in some cases 40% lower", and Iberia has had little choice but to keep costs low. The carrier, he says, is even making money out of its short-haul network - a rare feat for a European major. The fact that Iberia has been able to regain market share in Spain over the past three years while also increasing its profits supports his claim.

Relatively low Spanish wages have been a major factor in keeping Iberia's costs down. And since it has relatively low productivity, the carrier evidently has the ability to reduce its cost base even further.

But until now, the airline's misfortune has been that Spain is also a relatively low-income, tourist destination country - with few high-income and business clients. However, Iberia's head of alliances, Guillermo Serrano, is expecting higher yields in the future from the premium cabin and plans to use them to "cross-subsidise lower-end traffic", enabling Iberia "to buy back a lot of diverted traffic".

A senior Iberia source adds: "We want to be the cheapest airline in tourist class while offering good quality and good service."

The carrier may soon get some additional extra help in its battle against the growing competition in its domestic market. Serrano says that Iberia is in "discussions" with BA about the "opportunities" presented by the British flag carrier's low-cost subsidiary Go, which was to begin flying out of London Stansted to Spain from the end of March. "We cannot exclude something within the context of oneworld...We have some ideas to be developed," he says.

Unions on board?

If Iberia's president and chief executive, Xabier de Irala, is to carry out his job effectively, he will have to do some convincing and reassuring of the airline's 25,000 workforce.

Capt Fernando Llaca de Posada, president of the Sepla pilots union, fears Iberia pilots will face the same fate as their counterparts at Deutsche BA and Air Liberté where, in his view, BA ownership brought about a deterioration in pay and union-employee relations. Ground staff unions have similar reservations about BA, and unions representing pilots and ground staff say they have already made enough sacrifices.

Ground staff unions CCOO and UGT also oppose Irala's plan to create legally independent subsidiaries. Antonio Sanchez Nieto of Comisiones Obreras says such restructuring of the group will lead to a drop in wages to "market levels", which in high-unemployment Spain could lead to a halving of salaries.

Irala talks of not wanting to "force the unions" on this matter and says the independent subsidiaries will "attract investors and therefore create employment".

Fortunately for Irala, his only industrial disputes are with pilots at Iberia's subsidiaries, Aviaco and Viva Air. Aviaco pilots are taking sporadic strike action in response to Iberia's alleged failure to honour its commitments to hire more pilots - a charge that Irala rejects, saying that Iberia has just hired 200 pilots, "more than Iberia hired over the last seven years". At loss-making charter carrier Viva Air, pilots downed tools in March for two days over Irala's decision to integrate the fleet and pilots into Iberia. Irala dismisses the disputes as "unreasonable", and is confident of resolving them.

In fact Irala appears to have won grudging support from a workforce that is used to too many short-lived political appointees to the post of chief executive. While describing Irala as sometimes "self-confident beyond limits", Sepla's Capt Llaca de Posada confesses that he still prefers the "devil you know".

The unions are also wondering what role, if any, they may have in company management after privatisation. Collectively, the unions hold 6% of Iberia's shares and they say that only by syndicating their respective stakes will they have any chance of a seat on the newly privatised company board. However Iberia's six unions admit that differences among themselves make such a move unlikely.